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Our hypothesis generates the following two predictions. First, if some firms split their stocks to keep their equity value from falling (perhaps to delay a market correction of their overvalued equity), we expect these firms to have poorer long-run stock performance compared with firms that split stocks for nonmanipulative reasons. Given that we use earnings quality as a proxy for firms’ intentions to manipulate, we expect splitting acquirers with lower earnings quality to perform worse in stock returns compared with splitting acquirers with higher earnings quality, after controlling for the effect of earnings quality on stock returns. Second, because acquirers benefit more from overvalued equity in stock-swap. | Journal of Financial Economics 19 1987 3-29. North-Holland EXPECTED STOCK RETURNS AND VOLATILITY Kenneth R. FRENCH University of Chicago Chicago IL 60637 USA G. William SCHWERT University of Rochester Rochester NY 14627 USA Robert F. STAMBAUGH University of Chicago Chicago IL 60637 USA Received November 1985 final version received December 1986 This paper examines the relation between stock returns and stock market volatility. We find evidence that the expected market risk premium the expected return on a stock portfolio minus the Treasury bill yield is positively related to the predictable volatility of stock returns. There is also evidence that unexpected stock market returns are negatively related to the unexpected change in the volatility of stock returns. This negative relation provides indirect evidence of a positive relation between expected risk premiums and volatility. 1. Introduction Many studies document cross-sectional relations between risk and expected returns on common stocks. These studies generally measure a stock s risk as the covariance between its return and one or more variables. For example the expected return on a stock is found to be related to covariances between its return and i the return on a market portfolio Black Jensen and Scholes 1972 Fama and MacBeth 1973 ii factors extracted from a multivariate time series of returns Roll and Ross 1980 iii macroeconomic variables such as industrial production and changes in interest rates Chen Roll and Ross 1986 and iv aggregate consumption Breeden Gibbons and Litzenberger 1986 . We examine the intertemporal relation between risk and expected returns. In particular we ask whether the expected market risk premium defined as the expected return on a stock market portfolio minus the risk-free interest rate is positively related to risk as measured by the volatility of the stock market. We have received helpful comments from Joel Hasbrouck Donald Keim John Long Charles Plosser Jay Shanken Lawrence .
